The US Dept. of Labor has proposed an amendment to the Employee Retirement Income Securities Act that would allow pension funds to purchase lower-rated mortgage and asset-backed securities that it is now prohibited from owning.

“I think it’s a very important development,” says Brian Lancaster, a managing director in Bear Stearns’ Financial Analytics and Structured Transactions Group. “As time goes by, it will bring in more investors and increase liquidity in these lower-rated tranches.” For example, the bid-offer spread for the AA, A, BBB and BBB- commercial mortgage-backed securities currently ranges up to 10 basis points and could tighten to 3 to 6 basis points, he says.

Currently, ERISA pension plans can buy BBB and subordinated corporate bonds but not similarly rated CMBS.

Lancaster, the author of a Bear Stearns report titled, Publication of Proposed ERISA Regulations Would Expand Investor Base in Lower Rated CMBS, notes that the largest initial investment increases are expected in the AA and A-rated sectors because they tend to be influenced less by the underlying real estate. A thorough understanding of real estate is typically required of those investing in BBB and BB- CMBS.

It may take some time before the amendment has much impact while pension managers get acquainted with this market. The proposal will become effective after a 45-day comment period. Objections filed during this time could delay implementation, but few expect negative comments.

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